Some Economics of Public Sector Pay

In my new NBER paper, I study how the pay of federal and city workers varies as a function of geography. In this blog post, I would like to sketch the results and explain why this work is mildly interesting. First, permit me to tell the backstory. Over 25 years ago, I was a student of Sherwin Rosen’s at the University of Chicago. Rosen’s students were taught a healthy dose of compensating differentials theory. This theory dates back to Adam Smith and to state it succinctly, the theory posits that you pay for quality. Higher quality shoes cost more than mediocre shoes, nicer neighborhoods feature higher housing prices than nasty neighborhoods. While this is “obvious”, such price variation is quite useful for economists because it allows us to use a market test to infer how much people value spatially tied attributes.

For example, suppose that a very nice apartment with no view of the beach sells for $420,000 while a similar apartment in the same building with a beach view sells for $620,000. If you buy the 2nd apartment, then you reveal that a lower bound on how much you value a beach view is $200,000. This is the revealed preference logic.

Sherwin Rosen argued that a worker’s earnings can also be used to study the valuation of tied attributes. For example, a job that features stress and fatigue will have to pay “combat pay” to attract and retain workers. This wage premium provides information on how much of a compensating differential is required to attract workers to low amenity jobs. Conversely, a job that is fun and rewarding emotionally can pay less. This is why business schools pay economists more than economics departments!

Now my paper.

Using the Federal executive branch micro data, I document that controlling for a large set of explanatory variables; the federal government pays men and women the same earnings! Relative to a worker based in Alabama, the average California federal worker only is paid 9% more. Given that California’s home prices are almost 3 times higher than Alabama’s this immediately indicates that federal workers who choose to be based in California are paying for California’s unique amenities.

In the 2nd half of the paper, I use several unique California administrative data sets. These data provide each worker’s annual earnings, benefits, and the city where the worker works. There are over 400 cities in my data set. For each city, I know the city’s county and I code up whether the city is a beach city (think of Malibu or Santa Monica). I document that California’s beach cities feature much higher levels of human capital and expensive housing. Such cities do not pay higher nominal wages to public sector workers. Similar to the Federal workers, public sector workers in high amenity places are paying for their amenities at work. Sherwin Rosen’s work continues to have explanatory power and is relevant for explaining the public sector’s spatial equilibrium.